During last week, the TIIE curve increased by nearly 10bp on average, particularly at the short end and, to a lesser extent, at the belly and rest of the curve. As a result, it flattened and remained inverted from the 2Y tenor onwards. As we have mentioned in our previous reports, the TIIE curve keeps pointing north at the short end as Banco de México will continue to hike its benchmark rate in tandem with the FOMC given that inflation remains under pressure. Indeed, markets are pricing in a terminal rate close to 10.0% in the next nine months. As we pointed out in our note “Banxico: Hoping for the best, preparing for the worst”, dated August 11, 2022, the central bank left the door open to further action, though it mentioned that the pace would depend on current circumstances. While this could mean either increasing or slowing the pace, we believe that Banxico will most likely follow in the footsteps of the FOMC and thus stand pat on our view that Banxico will end the tightening cycle in 2022 with a terminal rate around 9.75%.
In terms of carry roll-down, considering a six-month horizon, drip continues to be positive at the very short end of the TIIE curve, especially in the 9M and 1Y tenors (nearly 70bp on average) as markets are factoring in a more aggressive approach from the central bank. As mentioned above, Banxico will most likely continue to tighten monetary conditions, which means that drip in that section is pricing in such action. On the other hand, swap spreads remain at lows as TIIEs outperformed MBonos except in the 9M and 1Y tenors, where a more aggressive approach from Banxico is being priced in.
The TIIE curve has flattened and remains inverted. Indeed, spreads all along the curve are at minimums, considering history since 2010. While the flattening has been too fast and aggressive, slopes have remained volatile. The reasons for an inverted curve remain, so we would expect low slopes and an inverted curve in the short term. However, the recent flattening has been so aggressive that markets are no longer pricing in more of it. Indeed, markets are starting to price in a steepening of the curve for the next six months as the neutral carry cost of a steepening strategy is close to 30bp, which means that right now the market is positioned for an increase in the slope. As we mentioned in our note “MX - The room is open to take steepening positions at the 2Y/10Y TIIE slope,” released on 28 July 2022, the case for a directional steepening strategy in the 2Y/10Y had started to make sense. Indeed, at that moment the carry cost was close to zero compared to the 30bp that the curve is pricing in with the latest data.
Finally, FRAs are discounting more hikes to come from Banxico and thus remain above spot levels from the 3M to the 1Y section. However, their spreads vs. spot rates have decreased in the latest weeks, especially from the 6M to 1Y tenors. Receiving forward rates and paying spot rates continues to make sense in that section, but room is more limited. In contrast, spread levels for the longer terms (2Y-10Y tenors) continue to decrease and are now in negative territory as the spot rate has moved more aggressively than what the forwards are pricing in. Indeed, in the 1Y/1Y vs. 2Y TIIE and the 3Y/2Y vs. 5Y TIIE, the spreads are at minimums, which enables paying the forward rate and receiving the spot rate.